What Happens if We Go Off the Fiscal Cliff?

The Congressional Budget Office weighed in last week on the fiscal cliff, the fact that a perfect storm of policy actions are scheduled to take place on Dec. 31 and Jan. 1. Its conclusion: If Congress and the president (who will be Barack Obama whatever happens in November) do not act together to forestall the automatic outcomes, the United States will head into recession, with growth shrinking significantly through the first half of 2013.

The CBO bases its analysis on the fiscal shock to a weak economy that would occur if, in one fell swoop, all the Bush tax cuts expired along with extenders such as the alleviation of the alternative minimum tax, the payroll tax cut, extension of unemployment benefits and the “doc fix” for Medicare, and the across-the-board sequesters take affect as scheduled. All combined would reduce taxable income, increase unemployment, depress consumption and retard growth. If none of the outcomes occur, growth in 2013 is projected to be robust, at 4.4 percent.

Of course, there is another side to the story. If we figuratively go off that fiscal cliff, the combination of tax increases and spending cuts will, over the medium and long run, reduce future deficits enough to put us on a firmly sustainable path. And while avoiding any of the tax increases and spending cuts will mean higher growth in the short run, it would dramatically hasten the time when we would see our debt and deficit problem spiral out of control.

The answer is pretty obvious: Find a way to avoid a downturn and also act to avoid a debt spiral — ideally, long before the deadline looms and long before markets catch on to the possibility of failure. That means a combination of phased and balanced spending cuts, including all areas of spending, and tax increases phased in to replenish the revenue base that is now the lowest as a share of the gross domestic product in nearly 60 years. That, of course, is just what the Simpson-Bowles Commission, the Rivlin-Domenici task force and the “gang of six” all recommended, with some variations on the same template.

The good news is that Alan Simpson and Erskine Bowles appear to be in discussions with 47 Senators from both parties to find a pathway to avert the fiscal cliff. The bad news is twofold.

First, there is zero sign that the House Republican majority has any interest in the tax increases that are a necessary component of the kind of package that Simpson and Bowles have laid out. (House Democrats such as Maryland Rep. Chris Van Hollen, in contrast, have signaled an openness to the kinds of changes in Medicare that are also required.)

Second, the fiscal cliff is both deeper and steeper than the CBO analysis would suggest. It includes the likelihood that there will be a showdown in December over fiscal 2013 appropriations, kicked down the road from Oct. 1 because House Republicans are just smart enough to know that a threatened shutdown of the government five weeks before the elections would not be a good idea. And another debt ceiling is looming, perhaps in early 2013 but conceivably by the end of the year.

The willingness of Senators in both parties to work hard to find a solution to this problem is a good sign and will provide some clues to whether 2013 will offer any hope. Bipartisan supermajorities in the Senate, allied in policy with Obama, might be able to force the House to compromise. But that, quite frankly, is a slender hope. When more than 95 percent of House Republicans have signed the Grover Norquist tax pledge, and the tax issue has become a total nonnegotiable demand, it would take a bold move by the Speaker, a willingness to rely on most Democrats and a minority of Republicans to reach a deal, that is nearly inconceivable — certainly before the elections.

After November, the dynamics of negotiation depend very much on the outcome of the elections. If Obama wins reelection and Congressional Republicans know they will have to deal with him for another four years, they might at least be inclined to negotiate with him in December. But the willingness to negotiate will be much higher if Democrats retain the Senate than if Republicans know that, come January, they have the leverage of a GOP Senate. The endgame will then slide into January at least.

What if Mitt Romney wins the presidency but Democrats hold the Senate? Some Republicans might prefer to cut a deal with Obama, to make sure their president can enter the White House without an economic cloud over his head and with many of the tough decisions made before that point. Romney has made it clear that he would prefer to have all the decisions deferred for a few months, having the deadlines extended. But it is in no way clear that Obama would agree to that plan.

Romney also made clear in his interview with Time’s Mark Halperin that he did not want deep budget cuts in 2013, making a Keynesian case that they would halt the recovery. But that is not the position Congressional Republicans take. Would he then ally with Senate Democrats against his own party? Not likely.

If Romney wins the White House and Republicans win the Senate, the willingness of Republicans to negotiate with a lame-duck president will go down dramatically.

Here, we know the game plan from House Budget Chairman Paul Ryan (R-Wis.): Run on the Ryan budget, win it all, hold on until after the inauguration, and in the meantime, plan “the mother of all reconciliation bills” to negate the defense sequester, double down on discretionary domestic budget cuts, make permanent the Bush tax cuts, enact a new tax cut on top of them, reducing the top rate to 25 percent, and do as much to turn Medicaid into a sharply reduced block grant to the states and create a premium support system for Medicare as revised reconciliation rules will allow.

What that plan would do to the fragile economy, to the safety net and to the long-term deficit and debt situation, is, or should be, a giant question now and through the election campaign.

Norman Ornstein is a resident scholar at the American Enterprise Institute.